Hi Steve,

I’d like to ask your (and HDCN readers) advice. I have been looking for a hot dog cart here in Cleveland, OH for some time. I found by shear accident that one cart owner is leaving Cleveland, moving to Texas.

Here are the details of our meeting yesterday: He has available, three carts total- two larger carts that he sells dogs/other sandwiches on, and one regular street cart. They are well used, but usable.Β 

Three locations in downtown Cleveland- one is a great location, one is probably a good location, and one is in a so-so or good location. Has permits for all three . AND, I think the best part of the deal- a COMMISSARY! The building is pretty beat up, BUT he has 2 guys each paying him $450 a month commissary rent. And building easily holds all 5 carts.

He has two guys that work for him at 25% of gross daily earnings. He tells me the two carts EASILY make $850/900 a DAY, with the third location taking it to $1000. As I write this I feel its a total good deal, even if he’s lying to me about the proceeds, say even HALF that amount of income would be a terrific buy.

I add that if I bought a cart myself, say $3,500, I would need commissary ($450 month), permits ($600+), and a location, which I would have to contact the City about (here in C-Town you are only allowed a specific location, I can’t just go where I want).

So I’m in a quandry about starting new amongst other hot dog carts in the city (where they all sell dogs for $1.50, pop .75 ). To top all of this off, I have no way of paying for any of the above, I have some investor friends that might be interested, or could you suggest how to find the financing?Β  I wanted to ask your advice first. Thanks in advance!

Sincerely,

BobD

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Hey Bob,

Sometimes we stumble upon opportunities by pure accident. I love it when that happens and I can totally understand your excitement. But let’s slow down and look at this thing from a few different angles.

The owner has an established, running business with three carts on the street. I like that a lot. The fact that the carts are well used doesn’t bother me too much because the value of this business doesn’t lie in the equipment. Used carts, even in great condition aren’t worth much.

So what is it worth? Business valuations depend on a great many things, but the general formula states that a business is usually worth two to three times earnings. Therefore, the value of this business lies not in it’s assets, but in the profits it currently generates.

Notice I said profits, not sales. A business with sales of $1000 a day is worthless if the expenses are $1002 a day. In order to properly value this business opportunity you need to know the numbers. What are the actual sales? What are the actual expenses? If the owner hasn’t kept proper records I would think long and hard about buying this or any business. (The Cash Tracker bookkeeping software to the right could have solved this problem.)

What is the history? If he does keep good financial records, the next thing I would want to know is the history of the business. How long has he been in operation of course, but even more importantly, how long has the business been making it’s current level of sales?

If this is a brand new business, that would drop the value. I know you said the carts were old but that doesn’t mean the business is. He could have bought those carts used. Check it out.

Even if this business has been around for a few years, you still need to look at the history. If the sales were flat at $400 a day for three years, then jumped to $1000 a day two months ago, I would devalue the business accordingly because this new level of sales may not be sustainable. We just don’t know yet.

Let’s talk about that commissary. He has one. That’s good. It has an income of $900 a month (you need to verify that). Also good. But is he making mortgage or rent payments on the building? If he owns it, what are the utility bills? Exterminator bills? Maintenance and repair bills? Does he have to pay someone to clean it? This commissary could be making money or it could be losing money. We just don’t know. Find out.

By the way, $450 a month for a commissary is a lot of money. If you want to know my strategy for getting a commissary for free, just email me. I’d be glad to tell you. No charge.

Employees. Asset or liability? He has two guys that work for him at 25% of gross daily earnings. That brings gross profits down to about 45% (assuming an industry average of 70% gross profits – again, find out what this particular business grosses) which is still quite good. I like that.

What worries me is loss control. How does the owner know the actual amount of sales? What’s stopping these guys from bringing 80 of their own hot dogs and buns to the cart once it’s at the location and selling them first, keeping 100 percent of those profits? Maybe this business is actually making $1300 a day, but only a grand gets reported to the boss. If there are no loss controls in place you need to figure out how to implement them if you intend to buy into this business.

My final concern is pricing. You say that everyone in the city sells hot dogs for $1.50. Is this business selling hot dogs that cheap? If so, you have a big problem here – and a great opportunity as you will see.

I have never believed in competing on price. I’ve seen it a thousand times. Someone starts a business, but they lack confidence. One thought dominates their mind, “I’m scared. How will I ever be able to compete?” Then they have a stroke of genius. They decide to offer the lowest price in their market!Β  And the funny (or tragic) thing is, they think this is their ticket to success. WRONG. Trying to offer the lowest price is the equivalent of committing business suicide for four main reasons.

  • First, it conveys a lack of quality. Everyone knows that you can’t possibly offer a good product at that price. This has the effect of decreasing sales, not increasing them. And forget repeat business. It will be virtually non-existent because you have no opportunity to brand yourself as anything other than the cheapest option. That’s how everyone will talk about you – how cheap you are, not how good you are.
  • Second, profit margins are the lifeblood of any business. Low margins mean you are constantly scrambling to meet your expenses. Your business is always staggering along on the edge of a cliff with no margin for error and the slightest mistake will have horrific consequences. If you like living with ulcers, commit yourself to consistently offer the lowest price in your market. Just be aware that the stress will take all of the fun out of the “funnest” business in the world. You’ll grow mean and you won’t be able to hide it. Again, bad branding to say the least.
  • Third, if you compete down at the bottom of the barrel where a low price is your only selling point, it’s just a matter of time before someone else comes along with an even lower price. Then you might as well stick a fork in it. You’re done. You’ll be in a race to see who can declare bankruptcy first.
  • Finally, you do your customers a massive disservice when you charge too little. If your margins are thin, you can’t do the extra things that make the customer experience an extraordinary one. And worst of all, you’ll probably be out of business soon, leaving your current customers high and dry. I heard a story about a young software company that was making the mistake of competing on price. They landed a big client who told them that they wanted to pay more for the software. Yes, they asked the company to charge them more. The reason why? They said that they liked the software and wanted to make sure the company would be in business a year from now so they could buy more from them when they needed it. They knew what happens to companies that charge too little.

Smart business don’t compete on price and here is where your opportunity lies. Sell a high quality product, give the customer a wonderful experience, and charge accordingly. You should be able to get at least $3 for a hot dog, $4 or more with the right presentation. You can charge twice the current price but your costs will probably only increase by 1/10th. That is good business.

Don’t pay asking price for the business. Once you have done your due diligence and determined a value for the business, it’s time to negotiate. Bring up all of the points discussed above and use them as leverage to lower the price. The less you pay, the better an investment it will be.

How will you pay for it? As far as financing goes, I would only consider outside investment if this was a sure thing. And you had better be SURE it’s a sure thing. You could talk to your local bank, but banks usually only lend money to people who don’t need it. You have your investor friends, and then there is owner financing. Maybe the owner will let you pay it off out of cash flow. This may be worth asking, even if you don’t intend to go this route. His answer will tell you a lot about the actual state of the business. If he wants to finance you out of the profits from the business after you take it over, that means he truly believes in his business.

Actually, I’m probably not the best person to ask about financing. I hate debt of any kind because it makes you a slave to the lender – literally. It’s bad enough with a bank, angel investors, or VCs. It’s worse with friends and relatives. When someone loans you money, all of a sudden they feel like they have the right to tell you how to run your business – and your life.

That’s why I’ve bootstrapped every business I’ve ever started. I’ve worked many a crappy job to get my seed money and lived as frugally as possible to keep as much of it as I could. You’ll be amazed at what bad jobs you can tolerate as long as you know it isn’t permanent, and that each day brings you closer to your goal of small business ownership – and more importantly, personal freedom.

To your success Bob – and success to all of my slingers out there in the dogosphere! I hope you all found this analysis useful.

-Steve

P.S. Let’s hear your thoughts in the comments. There’s a lot to talk about here…